United States

U.S. Supreme Court issues CSX ruling

Remands for consideration of justification for discrimination

TAX ALERT  | 

On March 4, 2015, the U.S. Supreme Court issued its ruling in Alabama Department of Revenue, et. al. v. CSX Transportation, Inc., reversing the Court of Appeals for the Eleventh Circuit's decision that Alabama's sales tax on railroad diesel fuel was invalid because it discriminated against a railroad in violation of the Railroad Revitalization and Regulatory Reform Act of 1976 (the 4-R Act). In addition, the Court remanded the case to the appeals court for reconsideration, with instructions to examine whether differences in the tax treatment of railroads and their direct competitors are justified.

Alabama imposes a 4 percent sales tax on purchases of tangible personal property within the state. Alabama also imposes a complementary use tax on tangible personal property used or consumed within the state where such property was not subject to sales tax on purchase. The Alabama sales and use tax applies to railroads on the purchase or use of diesel fuel in rail transport activities. However, this tax does not likewise apply to motor carriers and interstate water carriers, which are both exempt from the 4 percent tax on diesel fuel purchased or used in trucking transport on the highways or interstate transport through navigable waters, respectively. In lieu of the 4 percent sales and use tax, motor carriers are subject to a $0.19 per gallon excise tax on diesel fuel. Water carriers, on the other hand, are entirely exempt from tax on their purchase or use of diesel fuel within Alabama.

The 4-R Act provides that the states are prohibited from imposing a tax other than a property tax "that discriminates against a railroad providing transportation." See 49 U.S. Code section 11501(b)(4). In 2008, CSX filed suit in the U.S. District Court for the Northern District of Alabama challenging the imposition of the 4 percent sales and use tax on the diesel fuel it purchased or used within Alabama on the grounds that the tax was discriminatory and violated the 4-R Act because it was not imposed upon CSX's competitors, specifically motor carriers and water carriers. The district court dismissed the suit on procedural grounds, finding that CSX could not invoke the 4-R Act to challenge sales and use taxes that apply to railroads but exempt their competitors in the transportation industry. CSX appealed this ruling to the Court of Appeals for the Eleventh Circuit, which affirmed the decision of the district court. CSX filed a petition for writ of certiorari with the U.S. Supreme Court, which granted this petition and reversed, allowing CSX's suit to proceed.

Addressing the merits of the case on remand, the district court determined that the appropriate comparison class for consideration was CSX's direct competitors, motor carriers and water carriers, rather than all other commercial and industrial taxpayers. In relation to motor carriers, the district court determined that the exemption from the sales and use tax provided to motor carriers is justified and non-discriminatory because motor carriers are subject to a roughly equivalent $0.19 per gallon excise tax that is not imposed on railroads. In relation to water carriers, the district court found that, although water carriers are clearly exempt from the sales and use tax and not subject to any other equivalent tax, CSX failed in its burden of proving a discriminatory effect because CSX offered no evidence regarding the percentage of the transport market held by interstate water carriers or the impact of the exemption for interstate water carriers on CSC's rail transport business. Accordingly, the district court ruled in favor of the state and dismissed CSX's suit for a second time.

CSX appealed again to the Court of Appeals for the Eleventh Circuit, which reversed the decision of the district court and held that the Alabama sales tax is discriminatory under the 4-R Act because railroads' purchases of diesel fuel are subject to sales and use tax while like purchases by motor and water carriers are exempt. In reaching this decision, the court of appeals agreed with the district court that the proper comparison class was CSX's direct competitors, but disagreed with the district court's finding that the excise tax on motor carriers rendered the application of the sales and use tax to railroads and not motor carriers non-discriminatory. Instead, the court of appeals looked solely to the sales and use tax, which it found clearly discriminated against railroads in favor of motor and water carriers by granting such carriers an exemption from tax to which railroads are not privy. Upon determining that discrimination had been established, the court of appeals turned to whether such discrimination was nevertheless justified. The court of appeals then determined that the burden of proving justification was upon the state and not CSX and that the state had failed to meet this burden because it offered no evidence justifying the difference in treatment.

The state filed a petition for writ of certiorari with the U.S. Supreme Court, which was granted. At oral arguments on Dec. 9, 2014, the counsel for the state disagreed with the lower courts' determination that the proper comparison class is CSX's direct competitors and asserted that the "courts should compare the taxation of railroads to the taxation of the mass of other businesses in the State with the focus on whether the State is targeting or singling out railroads for a tax that the general mass of other businesses do not have to pay." Additionally, counsel for the state argued that the Court should evaluate the overall fairness of Alabama's tax structure, weighing the state's "reasons for the exemptions in its tax code […] with a focus on whether the railroads are suffering any practical disadvantage." Counsel for CSX disagreed with these contentions, supporting the court of appeals decision and arguing that, even if comparability between the sales and use tax and the excise tax on motor carriers is necessary to determine whether discrimination existed in that regard, the sales and use tax is still facially discriminatory because of Alabama's treatment of water carriers.

The Court, in a 7-2 decision with Justice Scalia writing the opinion, rejected Alabama's argument that the comparison class should be all commercial and industrial taxpayers and concurred with the lower courts that the appropriate comparison class was motor and water carriers. The Court then reversed the court of appeals' determination that Alabama's sales and use tax had to be looked at in a vacuum to determine whether discrimination exists and, without issuing its own determination regarding the existence of discrimination, found that the requisite considerations were (1) whether Alabama's excise tax on motor carriers is the "rough equivalent of Alabama's sales tax as applied to diesel fuel" and therefore justified the exemption from sales and use tax conferred upon motor carriers within the meaning of the dormant Commerce Clause, and (2) whether there is sufficient justification for the exemption for interstate water carriers. Accordingly, the Court, placing the burden of proof squarely on the state, remanded the case to the court of appeals to examine whether the state's justifications were sufficient to overcome a finding of discrimination.

Justice Thomas, with Justice Ginsburg joining, wrote a dissent, arguing that the appropriate comparison class is all commercial and industrial taxpayers and that the sales and use tax was not discriminatory because it did not single out railroads for disparate treatment. The dissent would have found that there was no discrimination against railroads resulting from the exemption applicable to motor carriers because that exemption could apply equally to railroads, and indeed any other industrial and commercial taxpayer, stating:

As far as I can tell, the railroads use dyed diesel that is exempt from the motor fuel tax-and therefore subject to the sales and use taxes-as a matter of choice rather than necessity. Dyed diesel has no special properties that make it more suitable for use in a train engine; the dye merely identifies it as exempt from the federal excise tax, §40-17-322(21). And no law prohibits railroads from using undyed diesel. To the contrary, it is the motor carriers who are prohibited from using the dyed variant for on-road use.

The dissent would have taken a similar approach to the question of whether the exemption for water carriers renders the sales and use tax discriminatory and would have found that no discrimination against railroads exists because water carriers, and not railroads, are singled out for disparate treatment.

The U.S. Supreme Court in its March 4 decision did not determine whether Alabama's sales and use tax regime is discriminatory in regard to railroads in violation of the 4-R Act. Instead, the court limited its ruling to agreeing with the lower courts as to the nature of the comparison class and instructing the court of appeals to consider on remand whether the state's justifications for its treatment of railroads relative to motor and water carriers are sufficient to uphold the state's application of its sales and use tax. Of import, the Court clearly explained that the imposition of a roughly equivalent excise tax on motor carriers could justify the exemption provided for those carriers from sales and use tax. However, the Court, still declining to make its own finding of discrimination, noted that the state "cannot offer a similar defense with respect to its exemption for water carriers. Water carriers pay neither tax." Although the Court provided some insight into how courts should analyze whether discrimination exists, this case is far from over, and it is entirely possible that the Court will see a third petition for writ of certiorari.

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